Accounting and Finance is the one module that most IB students tend to avoid. On account of the mathematical applications in the module, students wrongfully assume a level of difficulty and rigor that the module would present to them. Accounting and Finance in and of itself is not only the most straight forward module to learn, but once understood, it also presents students with a non-subjective opportunity to score points. The IBO has duly noted the tendency of students to avoid the subject area and has therefore made it one of the potentially compulsory structured question questions that would appear in Paper One (Section B) of the IB Business and Management examination. Consequently students are well advised to ally their fears and take on the Accounting and Finance module with an open and unfettered mind.
Mastering Accounting and Finance will open the world of business organization and its environment to the student in ways that will be well served in the future. Competence in Accounting and Finance provides students with unique insight into a world of specialized knowledge.
3.1 Sources Of Finance Evaluate the advantages and disadvantages of each form of finance. Evaluate the appropriateness of a source of finance for a given situation.
To make money, one needs money. The production process is also in need of finance for the entrepreneur to procure the needed capital, labor or land in order to engage the production process. The sources of this finance are dependent on a number of variables that are referred to as organic or internal and inorganic or external sources of finance. Once the business is underway, it may need additional resources to expand or realize strategic decisions and planning.
Internal Finance Organic sources of finance are a means of raising resources from within the business organization. These internal sources of finance can be from the sale of goods and services obtained through the production process, thereby raising the required liquidity. Raising finance through this approach is the objective of the business enterprise and has the greatest advantage of all, realizing profits through the production process, which could lead to expansion prospects and natural growth. However, when this Retained Earnings or Profit is reverted into the business organization, it inevitably will mean that shareholders will not receive the dividends, which equates to their share of profits being reinvested. Therefore, potential stakeholder conflict may arise where the strategic planning and decisions of management may clash with the aforementioned shareholders.
Firms may also reduce their capital investment by lowering their purchase of raw materials and operating on a tighter budget in order to raise or preserve the needed capital. These restructuring and efficiency programs include, for example the adoption of lean production methods and other cost saving approaches. The sale of assets within the organization itself would mean that the very resources needed to created productive output would no longer be available. Nevertheless, this is sometimes an option that some business’ are faced with as a last resort.
In order to cut costs, personnel, also considered assets, are generally the first to be released since the payroll expense is usually the highest cost factor in the business operations. Therefore the disadvantage of selling or releasing assets also referred to as the going concern or reducing your productive capacity is linked to the fact that you need the assets to conduct business. Personnel are also difficult to replace and train since they make up the very core of the business itself. However, firms are in the practice of selling unprofitable units such as subsidiaries, and declaring redundancies in order to reduce losses and raise the needed liquidity during credit squeezes. If enough resources can be raised through the generation of sales revenue, this always is the healthiest business option. External Finance Inorganic or external sources of finance are means by which firms seek finance that are external to the business organization. External Sources of finance may be either short-tem or long term. As defined in business, the short term is 0-18 months, the mid-term 18 months to 5 years, and the long term 5 years and beyond.
When the business organization first begins operations, it seeks start-up capital, which is sourced externally. Borrowing $500 from your grandmother and eventually making a fortune is an external sourcing of finance that some successful entrepreneurs have written about in their autobiographies!
Let us take a look at the options businesses have in raising finance externally, as there are clear advantages and disadvantages, which therefore calls for the most appropriate from of finance for a given situation.
Debts or Loans Finance in the long, medium and short term Debentures are the traditional name that financial experts use to refer to loan agreements where the debtor is a company and no security or collateral is has been placed. Collateral is an asset that is placed in the hands of the loan giver as security or surety, which serves to guarantee the loan. The debenture is therefore a non-securitized loan. Creditors are interested in their Return on Investment, in the form of interest payments, and Return of Investment (ROI), the principal amount loaned. In order to ensure that the ROI is certain with debentures, debtors therefore rely more on creditworthiness, which is based on a history of payments and a certain degree of good faith or trust.
Loans instruments can be either short-term, long term, overnight, or among others, in the form of an account overdraft protection policy. The primary disadvantage associated with these debt instruments, is that they carry a repayment burden in the form of interest. Short-and long term loans can be negotiated with the creditors, i.e. banks and other lending institutions in order for the business organization to ensure a competitive rate of interest. Generally, however, the shorter the loan period, the higher the rate of interest that the lending institution would charge.
Overdraft protection Overdraft protection is another form of finance which simply refers to the business organization being allowed to overdraw on its banking account payments, with the security of knowing that the banking institution will meet the payment obligations up to an agreed amount. A clear advantage is the ease of access to finance coupled with the ability of allowing the business organization to continue engaging in its productive process uninterrupted. In other words whenever the business organization needs the additional finance it does not need to continually fill-out forms or await approval from the lending organization.
**Bonds**Corporations also raise finances through the issuance of debt instruments known as Bonds. These are effectively debentures, which require payment of interest either during the period of issuance or at maturity, when the bond period expires. Bonds are transferable meaning they may be issued to other individual bondholders or investors. Only limited corporations have the right to raise funds through the issue of Bonds or Shares. Smaller businesses and individuals generally have the option of long term loans or loans issued for the purchase of real estate, known as Mortgages. A mortgage is therefore usually issued with the pledge of a specific asset.
Equity or Share Issues Long-term inorganic sources of finance are also available to the business organization. Private as well as publicly listed corporations both have the ability to raise funds by issuing shares or stocks of their business. Share issuing corporations, however, do not have the privilege of controlling share ownership once shares have been issued to individuals, business’ or other corporations. The greatest disadvantage of this source of finance is the loss of ownership and control.
**Initial Public Offering**Once publicly listed corporations issue shares, they no longer can retract ownership therefore they effectively given away a portion of the business. Nevertheless, this source of finance is virtually limitless, subject only to the faith and willingness the public to provide the finance in anticipation of gains. Take exceptional note however, that the publicly listed corporations, having gone through an extremely difficult and expensive qualification process, operate under strict guidelines and regulations.
The qualification requirement and cost of an Initial Public Offering (I.P.O) is a distinct disadvantage that may indeed outweigh the need to raise resources from the general public. Private corporations are also guided by regulations that allow them to seek finance from select members of the public. Although less restrictive and arduous, the private corporations must also comply with certain conditions which vary from country to country. Nevertheless, once again the private corporation would also be relinquishing some control and ownership. For the smaller business’ Venture Capitalists and Business Angels also serve as a viable source of inorganic finance.
Venture CapitalistsVenture capitalists are either individuals or business’ who specialize in seeking out viable business enterprises, and through a process of scrutiny will provide the needed finance for a stake in the “adventure”. The expectation of venture capitalists is that they will provide the needed finance for a business that will soar to unprecedented heights and in the process replace the high risk taken in the new business idea with the rewards of success. However, the disadvantage of such an arrangement is that the venture capitalists generally require a large portion of the business to be turned over to them if not total control.
Business AngelsBusiness Angels are wealthy individuals or groups of wealthy individuals who are independently wealthy and willing to support a business also for a stake as opposed to business orientated organizations who are actively engaged in the business of financing new ventures. The advantage of being associated with these individuals and organizations is that the finance is readily available and the required expertise in operating the new business will most likely also be provided. However, once again the disadvantage lies in the stake taken in the business.
In making the determination of which source of finance is beneficial to the business organization, multiple factors have to be considered. Among these are the Risk/Return ratio or the benefits derived from sourcing relative to the gains. Investment Appraisal is a means by which business organizations can determine the best course of action.
Reflection Point
In order to make money you need money. Most stories of success and fame begin with someone borrowing $500 USD from there grandmother. It is not a coincidence, but clearly your grandmother is also a source of finance.
In this section, we need to consider the various sources of finance available to the business organization. These can be either organic (internal) or inorganic (external) sources.
Complete the activity titled Sources of Finance and submit you decision with explanations for cases 1 through 10.
IB Corner
A. Pretend you are the CEO of a corporation in need of liquidity. Assess the advantages and disadvantages of financing each proposal below. 1. Leasing equipment 2. Issuing more shares; 3. Taking out an overdraft from the bank
B. If you were a bank manager and had to decide whether to give the corporation a loan or not what information would you need to help you decide?
Accounting and Finance is the one module that most IB students tend to avoid. On account of the mathematical applications in the module, students wrongfully assume a level of difficulty and rigor that the module would present to them. Accounting and Finance in and of itself is not only the most straight forward module to learn, but once understood, it also presents students with a non-subjective opportunity to score points. The IBO has duly noted the tendency of students to avoid the subject area and has therefore made it one of the potentially compulsory structured question questions that would appear in Paper One (Section B) of the IB Business and Management examination. Consequently students are well advised to ally their fears and take on the Accounting and Finance module with an open and unfettered mind.
Mastering Accounting and Finance will open the world of business organization and its environment to the student in ways that will be well served in the future. Competence in Accounting and Finance provides students with unique insight into a world of specialized knowledge.
3.1 Sources Of Finance
Evaluate the advantages and disadvantages of each form of finance.
Evaluate the appropriateness of a source of finance for a given situation.
To make money, one needs money. The production process is also in need of finance for the entrepreneur to procure the needed capital, labor or land in order to engage the production process. The sources of this finance are dependent on a number of variables that are referred to as organic or internal and inorganic or external sources of finance. Once the business is underway, it may need additional resources to expand or realize strategic decisions and planning.
Internal Finance
Organic sources of finance are a means of raising resources from within the business organization. These internal sources of finance can be from the sale of goods and services obtained through the production process, thereby raising the required liquidity. Raising finance through this approach is the objective of the business enterprise and has the greatest advantage of all, realizing profits through the production process, which could lead to expansion prospects and natural growth. However, when this Retained Earnings or Profit is reverted into the business organization, it inevitably will mean that shareholders will not receive the dividends, which equates to their share of profits being reinvested. Therefore, potential stakeholder conflict may arise where the strategic planning and decisions of management may clash with the aforementioned shareholders.
Firms may also reduce their capital investment by lowering their purchase of raw materials and operating on a tighter budget in order to raise or preserve the needed capital. These restructuring and efficiency programs include, for example the adoption of lean production methods and other cost saving approaches. The sale of assets within the organization itself would mean that the very resources needed to created productive output would no longer be available. Nevertheless, this is sometimes an option that some business’ are faced with as a last resort.
In order to cut costs, personnel, also considered assets, are generally the first to be released since the payroll expense is usually the highest cost factor in the business operations. Therefore the disadvantage of selling or releasing assets also referred to as the going concern or reducing your productive capacity is linked to the fact that you need the assets to conduct business. Personnel are also difficult to replace and train since they make up the very core of the business itself. However, firms are in the practice of selling unprofitable units such as subsidiaries, and declaring redundancies in order to reduce losses and raise the needed liquidity during credit squeezes. If enough resources can be raised through the generation of sales revenue, this always is the healthiest business option.
External Finance
Inorganic or external sources of finance are means by which firms seek finance that are external to the business organization. External Sources of finance may be either short-tem or long term. As defined in business, the short term is 0-18 months, the mid-term 18 months to 5 years, and the long term 5 years and beyond.
When the business organization first begins operations, it seeks start-up capital, which is sourced externally. Borrowing $500 from your grandmother and eventually making a fortune is an external sourcing of finance that some successful entrepreneurs have written about in their autobiographies!
Let us take a look at the options businesses have in raising finance externally, as there are clear advantages and disadvantages, which therefore calls for the most appropriate from of finance for a given situation.
Debts or Loans
Finance in the long, medium and short term
Debentures are the traditional name that financial experts use to refer to loan agreements where the debtor is a company and no security or collateral is has been placed. Collateral is an asset that is placed in the hands of the loan giver as security or surety, which serves to guarantee the loan. The debenture is therefore a non-securitized loan. Creditors are interested in their Return on Investment, in the form of interest payments, and Return of Investment (ROI), the principal amount loaned. In order to ensure that the ROI is certain with debentures, debtors therefore rely more on creditworthiness, which is based on a history of payments and a certain degree of good faith or trust.
Loans instruments can be either short-term, long term, overnight, or among others, in the form of an account overdraft protection policy. The primary disadvantage associated with these debt instruments, is that they carry a repayment burden in the form of interest. Short-and long term loans can be negotiated with the creditors, i.e. banks and other lending institutions in order for the business organization to ensure a competitive rate of interest. Generally, however, the shorter the loan period, the higher the rate of interest that the lending institution would charge.
Overdraft protection
Overdraft protection is another form of finance which simply refers to the business organization being allowed to overdraw on its banking account payments, with the security of knowing that the banking institution will meet the payment obligations up to an agreed amount. A clear advantage is the ease of access to finance coupled with the ability of allowing the business organization to continue engaging in its productive process uninterrupted. In other words whenever the business organization needs the additional finance it does not need to continually fill-out forms or await approval from the lending organization.
**Bonds**Corporations also raise finances through the issuance of debt instruments known as Bonds. These are effectively debentures, which require payment of interest either during the period of issuance or at maturity, when the bond period expires. Bonds are transferable meaning they may be issued to other individual bondholders or investors. Only limited corporations have the right to raise funds through the issue of Bonds or Shares. Smaller businesses and individuals generally have the option of long term loans or loans issued for the purchase of real estate, known as Mortgages. A mortgage is therefore usually issued with the pledge of a specific asset.
Equity or Share Issues
Long-term inorganic sources of finance are also available to the business organization. Private as well as publicly listed corporations both have the ability to raise funds by issuing shares or stocks of their business. Share issuing corporations, however, do not have the privilege of controlling share ownership once shares have been issued to individuals, business’ or other corporations. The greatest disadvantage of this source of finance is the loss of ownership and control.
**Initial Public Offering**Once publicly listed corporations issue shares, they no longer can retract ownership therefore they effectively given away a portion of the business. Nevertheless, this source of finance is virtually limitless, subject only to the faith and willingness the public to provide the finance in anticipation of gains. Take exceptional note however, that the publicly listed corporations, having gone through an extremely difficult and expensive qualification process, operate under strict guidelines and regulations.
The qualification requirement and cost of an Initial Public Offering (I.P.O) is a distinct disadvantage that may indeed outweigh the need to raise resources from the general public. Private corporations are also guided by regulations that allow them to seek finance from select members of the public. Although less restrictive and arduous, the private corporations must also comply with certain conditions which vary from country to country. Nevertheless, once again the private corporation would also be relinquishing some control and ownership. For the smaller business’ Venture Capitalists and Business Angels also serve as a viable source of inorganic finance.
Venture CapitalistsVenture capitalists are either individuals or business’ who specialize in seeking out viable business enterprises, and through a process of scrutiny will provide the needed finance for a stake in the “adventure”. The expectation of venture capitalists is that they will provide the needed finance for a business that will soar to unprecedented heights and in the process replace the high risk taken in the new business idea with the rewards of success. However, the disadvantage of such an arrangement is that the venture capitalists generally require a large portion of the business to be turned over to them if not total control.
Business AngelsBusiness Angels are wealthy individuals or groups of wealthy individuals who are independently wealthy and willing to support a business also for a stake as opposed to business orientated organizations who are actively engaged in the business of financing new ventures. The advantage of being associated with these individuals and organizations is that the finance is readily available and the required expertise in operating the new business will most likely also be provided. However, once again the disadvantage lies in the stake taken in the business.
In making the determination of which source of finance is beneficial to the business organization, multiple factors have to be considered. Among these are the Risk/Return ratio or the benefits derived from sourcing relative to the gains. Investment Appraisal is a means by which business organizations can determine the best course of action.
In order to make money you need money. Most stories of success and fame begin with someone borrowing $500 USD from there grandmother. It is not a coincidence, but clearly your grandmother is also a source of finance.
In this section, we need to consider the various sources of finance available to the business organization. These can be either organic (internal) or inorganic (external) sources.
Complete the activity titled Sources of Finance and submit you decision with explanations for cases 1 through 10.
A. Pretend you are the CEO of a corporation in need of liquidity. Assess the advantages and disadvantages of financing each proposal below.
1. Leasing equipment
2. Issuing more shares;
3. Taking out an overdraft from the bank
B. If you were a bank manager and had to decide whether to give the corporation a loan or not what information would you need to help you decide?